CMS Updates Medicare Policy Regarding Outpatient Observation

On May 22, 2009, CMS published changes to the Medicare Benefit Policy Manual and Medicare Claims Processing Manual related to outpatient observation. The changes are set forth in Transmittal 1745 and will become effective July 1, 2009. The changes delete references to “admission” and “observation status” in relation to outpatient observation services. CMS acknowledged that the term “admission” is confusing to hospitals, because hospitals generally use the term “admit” to indicate an inpatient admission. Further, CMS stated that since there is no payment status called observation status, the term “observation status” also could confuse hospitals. Observation care is an outpatient service, which is ordered by a physician and reported with the HCPCS code.

During the RAC demonstration program, many hospitals experienced claim denials where the RAC denied an inpatient hospital service as not medically necessary, but the RAC found that outpatient observation services would have been medically necessary for the patient. While Transmittal 1745 seeks to provide clarification between the two concepts of inpatient hospital services on one hand, and outpatient observation services on the other, the changes fail to provide a meaningful distinction.

Additionally, Transmittal 1745 contains provisions seeking to clarify the use of condition code 44, and a new section entitled “Policy and Billing Instructions for Condition Code 44” was added to Chapter 1 of the Medicare Claims Processing Manual.


In preparing for the expected scrutiny of short hospital stay cases, hospitals are well advised to take a critical look at the “order” process for inpatient admissions. The Medicare Benefit Policy Manual (CMS Internet-Only Publication 100-02), Chapter 1, Section 10 reflects that.

An inpatient is a person who has been admitted to a hospital for bed occupancy for purposes of receiving inpatient hospital services. Generally, a patient is considered an inpatient if formally admitted as an inpatient… The physician or other practitioner responsible for a patient’s care at the hospital is also responsible for deciding whether the patient should be admitted as an inpatient.

Our experience in appealing denials of short stay cases in the demonstration program often revealed records containing no formal order for inpatient admission signed by the admitting physician. Many cases revealed orders for admission with no specificity as to whether or not the order was for outpatient or inpatient admission, orders for a particular unit where both inpatient and outpatient admitted patients were housed and many cases with no order at all.

For more information regarding RACs, please call Abby Pendleton, Esq. or Jessica L. Gustafson, Esq. at (248) 996-8510, visit The HLP website’s RAC, Medicare and Other Payor Audits page, or visit The HLP website.

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